Comerica Inc (CMA) 2017 Q2 法說會逐字稿

Good morning, my name is Regina, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Comerica Second Quarter 2017 Earnings Conference Call.

(Operator Instructions)

I would now like to turn the conference over to Darlene Persons, Director of Investor Relations.

Ma'am, you may begin.

Thank you, Regina.

Good morning, and welcome to Comerica's Second Quarter 2017 Earnings Conference Call.

Participating on this call will be our Chairman, Ralph Babb; President, Curt Farmer; Chief Financial Officer, Dave Duprey; and Chief Credit Officer, Pete Guilfoile.

During this presentation, we will be referring to slides to provide additional detail.

The presentation slides and our press release are available on the SEC's website as well as in the Investor Relations section of our website, comerica.com.

Before we get started, I would like to remind you that this conference call contains forward-looking statements.

And in that regard, you should be mindful of the risks and uncertainties that can cause actual results to vary materially from expectation.

Forward-looking statements speak only as of the date of this presentation, and we undertake no obligation to update any forward-looking statements.

I refer you to the safe harbor statement in today's release, in Slide 2, which I incorporate into this call, as well as our SEC filings for factors that could cause actual results to differ.

Also, this conference call will reference non-GAAP measures.

In that regard, I would like to direct you to the reconciliation of these measures within this presentation.

Now I'll turn the call over to Ralph, who will begin on Slide 3.

Good morning.

Thank you for joining our call.

Today, we reported second quarter 2017 earnings per share of $1.13 compared to $1.11 for the first quarter.

Excluding restructuring charges and tax benefits from employee stock transactions, adjusted earnings per share was $1.15 compared to $1.02 for the first quarter, a 13% increase.

Our results shall drive a double digit ROE and efficiency ratio below 59% and a 1.14% ROA for the quarter.

Relative to the second quarter of last year, our earnings per share increased 95%, and on an adjusted basis excluding restructuring charges and tax benefits from employee stock transactions, our EPS increased nearly 50%.

This was due to higher interest rates and improved credit quality in our Energy portfolio as well as lower expenses and increased fee income resulting from the success of our GEAR Up initiative.

Turning to Slide 4 and an overview of our second quarter results.

Average loans for the second quarter were up $823 million or 2% compared to the first quarter.

Seasonality helped drive increases in Mortgage Banker and National Dealer Services.

Also middle market average loans were up 2%, with growth in all 3 of our markets, particularly California.

This was partly offset by a decrease in Energy loans, however, the pace of decline has slowed.

As far as deposits, average balances declined about 1%, partly due to seasonality following very strong deposit growth in the back half of last year.

In fact, average deposits are up over $600 million relative to the second quarter last year.

We are carefully monitoring our deposit base and so far, had made no changes to our standard deposit pricing.

Net interest income increased $30 million or 6% to $500 million primarily driven by the benefit from increased interest rates and loan growth.

Overall credit quality continued to be strong with declines in criticized and nonaccrual loans and net charge-offs of only 15 basis points.

This, combined with our second quarter loan growth, drove a 4 basis point decline in the allowance for loan losses to 1.43% of total loans.

The total reserve remains stable, resulting in a provision of $17 million.

Noninterest income grew 2% with increases in card and commercial lending fees as well as customer derivative, fiduciary and brokerage.

This partly reflects the traction we are gaining in several of our revenue focused GEAR Up initiatives.

Excluding a $3 million increase in restructuring charges, noninterest expenses decreased 1%.

Salaries and benefits expense decreased $14 million following elevated annual comp expenses in the first quarter.

This was partially offset by increases in advertising and operational losses as well as higher litigation-related expenses due to a favorable settlement in the first quarter of 2017.

Of note, expenses decreased significantly relative to the second quarter last year even excluding restructuring charges as we continued to closely manage our expenses and reap the benefits from our GEAR Up initiatives.

We increased our payout to our shareholders as we repurchased $139 million or 2 million shares and increased our dividend by 13%.

In addition, we recently announced our 2017 capital plan, which includes a further increase in our quarterly dividend of $0.30 per share, which will be considered by the board at the end of this month.

The plan also calls for share repurchases up to $605 million, which is about a 40% increase over the 2016 plan.

We expect to continue to gradually increase our total payout to shareholders as we progress through the year.

And now, I will turn the call over to Dave, who will go over the quarter in more detail.

Thanks, Ralph.

Good morning, everyone.

Turning to Slide 5. As Ralph mentioned, second quarter average loan increased $823 million compared to the first quarter, including a $123 million decline in Energy loans.

Mortgage Banker loans were over $300 million with a normal pickup in spring home sales partly offset by modestly shorter time the mortgages sitting in the warehouse, known as dwell time.

Our portfolio continues to be heavily weighted to home purchases, with approximately 85% purchase versus refi compared to the industry average of 68%.

Our auto Dealer Floor Plan portfolio also increased over $300 million as a result of seasonal buildup in auto inventory as well as the addition of several newer expanded relationships.

We had an increase of nearly $200 million or 2% in general Middle Market with good activity in all 3 of our markets, particularly in California.

In addition, we saw growth across a number of our key specialty national business lines including Technology and Life Sciences, U.S. Banking, International, Environmental Services and Wealth Management.

Partly offsetting this growth was a decrease in Energy loans.

However, as anticipated, the pace of decrease in Energy loans has slowed.

The decline in the second quarter was less than half of what we saw in the first quarter.

This is partly due to reduced asset sales in capital markets activity, which is a result of the recent decline in commodity prices.

Total period-end loans increased $1.1 billion with the largest contributions from Mortgage Banker and Dealer.

Our loan yield increased 17 basis points.

Higher rates including a 23 basis point increase in average 30-day LIBOR added 19 basis points to our yield.

This was partly offset by a lease residual valuation adjustment.

Our loan pipeline increased in the second quarter with the majority from new customer opportunities.

Overall, the sentiment is positive, reflective of the improving economy and anticipated changes coming out of Washington, yet customers continue to be cautious.

Average deposits declined modestly over the first quarter, as shown on Slide 6. Middle Market declined nearly $500 million due to seasonality and customers utilizing their cash in their businesses to meet increasing working capital needs, and we expect this may continue.

Also, municipal deposits declined as they typically do following tax collection in the first quarter.

Energy balances were down with the slowdown in capital markets activity.

On the positive side, Commercial Real Estate balances grew as certain larger customers have been accumulating cash as they access the market to take advantage of low rates.

Also, as you can see by the increase in Retail Banking and Wealth Management, we had seasonal growth in consumer deposits, which comprised 1/3 of our deposit mix.

Period-end deposits declined $2.1 billion to $56.8 billion with Middle Market and Municipalities being large drivers as well as Corporate.

Of note, our loan-to-deposit ratio remains relatively low at 87%.

We continue to prudently manage deposit pricing.

We are closely monitoring our deposits as well as the market.

Our securities book remains at about $12 billion, as shown on Slide 7. The total yield in the portfolio increased 4 basis points as we have been able to make purchases at slightly higher rates than the paydowns.

For example, we have seen MBS yields around 2.50, with only modestly longer duration than the portfolio average.

The estimated duration of our portfolio is about 3.3 years and the expected duration under a 200 basis point rate shock extends it modestly to 3.9 years.

Finally, the portfolio is in a relatively small unrealized net loss position of $21 million.

Turning to Slide 8. Net interest income increased $30 million, while the net interest margin increased 17 basis points to 303.

Our loan portfolio added $32 million, 13 basis points to the margin.

Increased interest rates provided the largest benefit, along with higher loan balances, 1 additional day in the quarter and other portfolio dynamics.

This was partly offset by lease residual adjustment of $4 million.

As far as our deposits at the Fed, the increase in the Fed funds rate added $4 million and was offset by a $1.2 billion decrease in average balances.

This resulted in the net benefit of 6 basis points to the margin.

Wholesale funding costs increased due to higher rates, and this had a 2 basis point negative impact on the margin.

In total, the increased rates contributed $23 million to net interest income.

Our overall credit picture remained strong as outlined in Slide 9. Total criticized loans declined over $140 million and are now about 5% of total loans at quarter end.

This includes a $28 million decrease in nonaccrual loans, which now represents 1% of our total loans.

Net charge-offs were 15 basis points or $18 million.

This included $39 million in gross charge-offs, which is a $5 million decrease from last quarter combined with strong recoveries of $21 million.

Reflecting continued strong credit quality, improving energy credit metrics and second quarter loan growth, the allowance-to-loan ratio declined 4 basis points to 1.43%.

Energy loans at quarter end were about $2 billion or 4% of our total loans.

We expect balances will remain at approximately this level.

E&P loans make up about 70% of our Energy portfolio.

Spring redeterminations are nearly complete and borrowing bases are up about 10% on average, with decreases in oil and gas reserves due to drilling activity and acquisitions.

The recent decline in energy prices is not expected to have a significant impact on our portfolio, as overall, our customers have lowered operating costs, reduced leverage and are appropriately hedged.

Criticized and nonaccrual loans as well as net charge-offs all decreased again in the second quarter, resulting in a decline in the reserve allocated for Energy loans to about 6% of Energy outstandings.

Credit metrics in our Commercial Real Estate portfolio are very strong with criticized loans representing less than 2% including only $8 million in nonaccrual loans.

We are closely monitoring the portfolio, and it continues to perform well under the stress tests we have conducted.

Slide 10 outlines noninterest income, which increased $5 million or 2%.

Overall, we are starting to see early success of our GEAR Up revenue initiatives.

We had strong card fees as well as increases in customer derivative, fiduciary and brokerage income.

In addition, commercial lending fees increased primarily due to higher syndication activity.

And we had over $3 million in warranties, which are included in other income.

Finally, investment banking fees declined from a robust first quarter activity.

Relative to a year-ago, excluding a $3 million decrease in deferred compensation asset returns, noninterest income increased $11 million with growth in nearly every line item.

As a reminder, changes in deferred comp are offset in noninterest expense.

Excluding the $3 million increase in restructuring charges, noninterest expenses declined $3 million, as shown on Slide 11.

Salaries and benefits decreased $14 million following annual share-based comp and higher payroll taxes in the first quarter.

This was partly offset by annual merit raises and 1 additional day.

Advertising expenses, which were seasonally low in the first quarter, combined with some strategic marketing opportunities in the second quarter, increased $3 million.

We had virtually no litigation related expenses in the second quarter.

However, in the first quarter, we had a favorable settlement, which provided a litigation-related credit.

Software costs increased as we continue to invest in product development, cybersecurity as well as efficiency opportunities.

Finally, operational losses were some somewhat elevated as these are difficult to predict and are not expected to continue at this level.

Overall, expenses remain well controlled and the realization of our GEAR Up initiatives continue to be evident.

Moving to Slide 12.

As Ralph mentioned, we announced last month that the Federal Reserve did not object to our 2017 capital plan, which includes equity repurchases up to $605 million.

In addition, later this month, our board will consider increasing the quarterly dividend to $0.30 per share.

We fully executed our 2016 capital plan, which included equity repurchases of $440 million.

In the second quarter, we again increased our stock buyback of $139 million of repurchases under our equity repurchase program.

Together with a 13% increase in our dividend, we returned $185 million or 91% of net income to shareholders.

During the second quarter, employee option exercises added about 424,000 shares.

This activity resulted in a credit to our income tax provision of $5 million or about $0.03 per share.

Now I'll turn the call back to Ralph.

Thank you, Dave.

On Slide 13, we've highlighted 2 major drivers of our financial performance.

This demonstrated again this quarter, our asset-sensitive balance sheet is well positioned to benefit from increases in rates.

Over 90% of our loans are floating rate, therefore, as rates rise, our loan portfolio reprices quickly.

Also, over 50% of our funding comes from noninterest-bearing customer deposits, which results in one of the lowest costs of funding among our peers.

We expect the December rate rise to contribute about $85 million to 2017 net interest income.

Given that we were able to judiciously manage our deposit pricing, we have updated our outlook for the March rate increase to now have $65 million.

And our model indicates that the June rate increase, assuming a 25% beta, could add another $30 million to $40 million to our 2017 net interest income.

Of course, the outcome depends on a variety of factors such as the pace at which LIBOR moves, deposit betas and balance sheet movements.

We continue to be on track to meet our GEAR Up expense and revenue goals that we announced last July.

With no consideration given to the benefit from increased rates, we remain committed to achieving our targets for an additional $180 million in pretax income in 2017 and $270 million in 2018 relative to when we kicked off the initiative in the spring of 2016.

Recent rate increases have helped us reach our targets faster for an efficiency ratio of below 60% and an ROE in the double digits.

Many of our larger initiatives, including a reduction in workforce and a redesigned retirement program, have been completed.

We have now successfully completed our goal of consolidating 38 banking centers, with the final 19 in close in the second quarter.

Two of the areas we are currently focused on are technology and our credit process.

On the technology front, we are rationalizing applications and designing ways to enhance efficiency.

As far as our end-to-end credit design project, implementation has begun, and we are seeing increases in our relationship managers' capacity and enhanced customer satisfaction.

This includes simplifying the governance process, introducing new technology to support a digital approach and pooling of back-office resources across all of our markets.

Finally, on Slide 14, we provide our outlook for the full year 2017.

Assuming continuation of the current economic environment, we now expect total average loans to increase about 1%.

Included in this is a significant decrease in our Energy loans, which are down about $900 million or 30% relative to the same period last year.

We are adjusting our total loan growth guidance to the lower end of the range that we had previously provided.

While we have always anticipated a decline in mortgage banker due to falling refi volumes, the reduction in dwell times due to high investor demand has had a further impact.

Also we remain focused on maintaining our pricing and underwriting discipline in a highly competitive market and continue to be highly selective in certain segments, like Commercial Real Estate and Technology and Life Sciences.

As a reminder, we typically see seasonal declines in Dealer and Mortgage Banker in the second half of the year.

In addition, our customers continue to be cautious given the uncertainty regarding Washington-based initiatives.

Aside from Mortgage Banker and Energy, we expect the remainder of the portfolio to grow about 3%.

As I mentioned a moment ago, the recent rate increases alone could drive more than $180 million or 10% increase in our 2017 net interest income.

In addition, we expect to benefit from loan growth and lower funding costs primarily due to repayment of sub-debt late last year.

Credit quality in the first half of the year has been very strong.

Therefore, we are reducing the upper end of our guidance and now expect the provision for the full year to be between 20 and 25 basis points and net charge-offs to remain low.

Our outlook for noninterest income growth of 4% to 6% has not changed.

As far as our outlook for noninterest expense, we are narrowing the range for expected restructuring expenses to be $40 million to $50 million.

We expect the remaining expenses to decline about 1% as we continue to be on track to meet our GEAR Up savings.

We are now guiding to the low end of the range we previously provided.

As a result of increased revenue, expenses tied to revenue are expected to increase, such as marketing expense, incentive compensation as well as outside processing expense, which is mostly tied to card fees.

Note that expenses in the second half of the year relative to the first half are impacted by 3 additional days as well as seasonally higher occupancy and benefits expenses.

Also technology expenditures are forecast to rise as expected as we invest in product innovation, cybersecurity and in our infrastructure in order to drive efficiencies.

In summary, our revenue increased 5% quarter-over-quarter and 9% year-over-year.

We have benefited meaningfully from increased interest rates as well as our relationship banking strategy, which is driving loan and fee growth.

In addition, credit quality continue to be strong.

We remain focused on carefully managing expenses and are committed to delivering on the GEAR Up efficiency and revenue opportunities.

Excluding restructuring charges and tax benefits from employee stock transactions, adjusted earnings per share increased 13% over the first quarter and nearly 50% from the second quarter of last year.

We believe we are well positioned for the future to further increase shareholder value.

And now, we will be happy to take your questions.

(Operator Instructions) Our first question will come from the line of Steven Alexopoulos with JPMorgan.

Ralph, looking at the sharp reduction in mid-market deposits that we saw in the quarter, historically we would have considered that a very bullish leading indicator for loan growth.

Is this the case or something else going on?

We believe that a lot of that reduction is an indicator that the Middle Market customers are using their excess deposits to invest in their business.

Curt, do you want to add anything to that?

I think you said it well, Ralph.

I think, Steve, that we are seeing and hearing anecdotally from clients that they are starting to pull down on deposits in Middle Market, but across many of our other business lines as well really for investment in their business.

Okay.

That's helpful.

In terms of the businesses being more confident, which we saw from just about every bank post the election.

Given the gridlock that we're seeing in Washington, on the flipside of them investing in their businesses, are you starting to see business confidence fade at all here?

I think what happens is our customers continue to be very cautious, and especially in the way they invest and for the time that they invest.

In other words, they may invest what they need for a year to meet demand, but they're not going out as far as they used to go.

Curt?

Yes, I think, Ralph, that's correct.

And I would say, we're not seeing a lot of CapEx spend but more in spending to meet current demand, working capital, et cetera, in, for example, core middle markets, small business, et cetera.

Okay.

And if I could just ask on the deposit side, you guys continue to assume a 25% beta now following the June hike.

Do you just remain very conservative or you're actually starting to see upward pressure on deposit cost?

At this point, we've made no -- as I said in my remarks, we have not moved our standard pricing.

We have not seen that at this point.

But we do plan for it at some point, I guess, is the right way to say it.

Curt, are you hearing anything different?

No.

We really are not seeing a lot of demand for any pricing exceptions and are not hearing anything from our competitors, but we stand ready to be competitive as needed and make sure our clients are taken care of.

Okay.

I mean, is it the expectation that if the Fed unwinds its balance sheet and liquidity drains that you will actually start to see betas move?

Is that part of this?

I wouldn't forecast that at this point.

I think that's been discussed.

And we have not seen a real impact at this point.

We'd like to see what happens when they actually begin the process and at what level it's being done.

Your next question comes from the line of Michael Rose with Raymond James.

Just a question on the margin.

It looks like you guys had a residual lease value adjustment that might had a negative on the margin.

Should we think about the margin being about 2 basis points higher than where it was?

That would be exactly, exactly right.

Okay.

And then just a lot of talk, and I know you guys aren't really too exposed, but a lot of talk over the past few months on retail lending.

Not sure if I missed it in the prepared remarks, but any just kind of broader thoughts on -- your thoughts on lending to the retail space?

Our retail lending has been very focused.

And it's not mass-market type of lending.

And we have no plans to really change that.

Pete, do you want to add anything to that?

Yes.

I mean, we only have about $700 million of C&I exposure in retail space, Mike.

And it's a very granular.

It's across a number of different businesses, across different geographies.

It's very granular, about -- on average, about $1 million of borrower.

And so it's not big exposures to large department store chains or anything like that.

And then, of course, the other area that we touch retail will be on the Commercial Real Estate side.

Most of our Commercial Real Estate retail exposure would be in the line of business, it's about $500 million.

And 70% of that would be, what we call, neighborhood shopping centers.

So think about a Starbucks, a Panera bread or grocery store, hair salon, that type of thing.

The patrons typically are within 5 miles of the shopping center.

And while those centers are not completely immune from Internet retailing, they typically do a little bit better and all of our projects are doing just fine.

We have no criticized loans in the retail Commercial Real Estate space.

Okay.

And then just one more, if I can, on Energy.

Where would we need to see Energy prices fall to, to start maybe seeing some additional credit issues pop up from here?

Pete?

Right now, the way we look at it is, first of all, any new deals that we're looking at, we are very selective in making sure that those borrowers can be successful in a period of prolonged low energy prices.

So we sensitize their cash flow and their collateral, it's typically 20% to 25% reduction in price from the strip that we are looking at.

So on the front end, any new deals, any deals that we're extending, we are being very selective there.

With regard to the ones that are still having some troubles, most of them are really selling their assets right now.

And if they cannot be competitive in a lower-priced environment, they are really moving those assets to somebody who feels that they can.

And so I know that's not an exact question or exact answer for you, but we feel pretty good about the portfolio, but we are very mindful of the fact that these borrowers are not as well hedged as they were, say, 3 years ago.

And so we have to be very selective.

Your next question comes from the line of Ken Usdin with Jefferies.

This is actually Josh from Ken's team.

So your outlook for average loan growth of up 1% year-over-year in 2017 implies a better growth for the second half of the year.

Could you speak to the moving pieces here?

Curt, do you want to go through that?

Yes, I would be glad to.

Josh, so we talked earlier about the lift we saw in the second quarter from our seasonal businesses, Mortgage Banker Finance and Energy.

Those typically run their course in the spring, summer season and so, we've started to see sort of a slowdown in those balances.

And we reflected that or the growth in those balances, we reflected that in our outlook comment.

But the rest of the portfolio, we are expecting growth.

And so core Middle Market, our Technology and Life Sciences business, Private Banking, we've seen some growth in Environmental Services, some of our larger businesses, our Corporate Banking, U.S. banking, for example.

So really across a majority of our business lines, we are expecting growth for the balance of the year.

And I think you saw that reflected in the second quarter results.

We had growth across all 3 of our Middle Market -- markets led by California.

And as Dave referred to and Ralph as well, kind of key leading indicator for us is commitments to commit as well as pipeline and the commitments to commit area, we were up another 11% after having been up about 44% in the first quarter.

So we feel like these kind of leading indicators will help us sort of sustain some growth into the second half of the year.

Okay.

And you still have a relatively large reserve on your Energy portfolio.

To what extent do you think you'll be able to continue to release or reallocate these reserves?

Pete?

Well, we've been releasing energy reserves really last several quarters, and we released some more this past quarter.

That results in overall reserve release because there are other things going on in the portfolio, namely loan growth.

I think the next big event will probably be the SNC exam in the fall.

We have a number of credits that we've gone through, redeterminations that we feel very comfortable upgrading those credits.

But we're going to wait until we see the results of the SNC exam.

And if we do, there'll be an opportunity to improve some risk ratings and perhaps reduce some additional reserves against the Energy portfolio.

Whether that translates into a release of reserves overall is really going to be a function of what else is going on in the portfolio, including loan growth.

And we're about 6% today.

Yes.

Our next question will come from the line of John Pancari with Evercore ISI.

Just 2 things on the guidance.

I'm sorry if I missed any clarification here.

On the fee guidance, I know you generally came in better than expected this quarter, and some of that was card, some of that was fiduciary.

But you still maintained the full year guidance of 4% to 6%.

Why not change that?

Well, John, this is a fairly wide range.

So we remain very comfortable we are going to be within that range.

Okay.

All right.

So in terms of carryforward from the trends for the quarter, there is no reason to then bump up the high end of that?

We are comfortable making the comments that we expect to be within that range of 4% to 6% overall for the year.

Okay.

All right.

Okay, and then separately on the expense side, I know 2Q numbers came in better than expected.

The -- but the guide now, you're looking for down 1% versus previously down 1% to 2% despite 2Q expenses coming in better.

I believe, on the call, you've indicated that partly reflects revenue coming in better.

Is that correct?

That's correct.

I would add, largely reflective of revenue coming in better.

Okay.

So if that's the case and revenue coming in better is partly tied to GEAR Up and GEAR Up is on track, why, therefore, not move the expense guide?

If things are on track and revenue's coming better, I'm just not sure why expenses wouldn't follow suit as well?

Well, expenses are still coming down, John.

We've always done is, again, tightened the range.

We had said overall ex restructuring, 1% to 2%.

And now we're simply saying that we think it's going to be closer to the 1% because revenue is tracking better.

So we've had higher outside processing costs because a lot of that nonloan revenue is processed by third parties.

It's very much volume based, and that volume also drives incentives.

And we've also taken advantage of some very opportunistic marketing opportunities, which we think will further advance revenue, not only for '17 but beyond.

When you add all that up, we have now shifted our view still in that 1% to 2%, we just feel it's coming closer to 1%.

Okay, so it's more about the opportunistic stuff, it sounds like then.

Absolutely.

Got it.

Okay.

All right.

And then lastly, not sure if you mentioned the efficiency ratio, sticking to the expense topic, but just wanted to get your thoughts longer term into how you're thinking about where the efficiency ratio could trend in '18?

We believe we can continue to push that number down.

Obviously, rate rises will help that even more.

We'll have to wait and see what the Fed does.

Your next question comes from the line of Jennifer Demba with SunTrust Robinson Humphrey.

This is actually [Steve] on for Jennifer.

Just wanted to see, what are you seeing in the Texas economy outside of the Energy business?

What are kind of the opportunities there in terms of loan growth?

When you look at the overall Texas economy right now, and Robert Dye, our Chief Economist, really looks at the U.S. being a GDP of about 2.4% and Texas is going to be above that at about 2.5%.

And as we've said before, the economy in Texas is much more diverse than it has been in history.

And Energy is only about 15% of the GDP.

When you look at our Texas economic activity index, it's increased for the last 8 months through April.

And so that's a positive sign that things are beginning to pick up and move in the right direction broadly.

Your next question comes from the line of Steve Moss with FBR.

I was wondering, on the Energy portfolio, if you'd discuss where your customer hedging position these days and where customer leverage is?

Pete?

We've seen a fair amount of hedging activity in the first half of the year.

It was very similar in terms of the level as last year.

And then we saw a significant drop-off in June with the different prices and now it's starting to pick back up again.

Overall, our borrowers are about as well hedged as they were a year ago or so.

But again, the value of the hedges continues to come down because more of those higher-value hedges run off with every quarter that goes by, and they're rehedging it at a lower level.

And that's why we mentioned earlier that focus on lifting costs becomes even more important today as we analyze borrowers and making sure that they can be successful, not just with their hedging, but be successful because they've got a low-cost structure.

Okay.

And with regard to customer leverage, just kind of wondering if you can give any metrics around that?

Leverage is definitely coming down, and that's probably one of the stark differences between what we saw in the portfolio 3 years ago versus what we see today.

It's a good 1 or 2 turns lower in leverage.

And so that's a real fundamental difference between the portfolios today and where it was 3 years ago.

If you can just comment a little bit too or Curt, if you can add to this.

But we've seen a lot of our customers selling properties at very high values.

Yes.

So there continues to be some pretty good asset sales.

And in most cases, when those sales take place, there's -- it's fairly accretive to liquidity, indicating that our borrowers are not very levered on their assets.

And so they can continue to raise equity by selling assets.

Okay.

And then I was wondering about National Dealer Services, what is your thoughts around the outlook for the business there given the auto market?

Curt?

Yes, that business continues to be one we like a lot, and we saw growth in the quarter but we are seeing the overall slowdown in the SAAR rate.

I think you have to keep in mind that it's still historically very high.

We have not seen a lot of impact in -- as far as reduction in our borrowing base with our dealers.

We do work with a lot of the stronger multifranchised dealerships.

Many of those have been in a net acquiring mode, so they've been strengthening their position overall.

Short term, a decline in the SAR rate actually helps as you see sort of longer days on the lot for the inventory.

Obviously longer term, if SAAR rates continue to go down, you will see some decline in borrowings but at least for the immediate future, we still feel good about sort of the prospects and growth in the portfolio.

Your next question comes from the line of Brett Rabatin with Piper Jaffray.

Wanted to go back to the margin and just ask, I guess, first in the securities portfolio, you mentioned MBS at 2.50.

Can you talk about how much you're investing, how much in cash flow you're getting off of securities portfolio in the next few quarters?

And then just thinking about the margin, aside from the June rate hike, is it fair to assume that your pricing efforts are at a higher yield than your current portfolio, i.e., you're not giving us spread compression on the new production?

Dave?

I'll comment first on the securities and then Curt can certainly comment on what he is seeing from a competitive perspective on loan pricing.

On the securities portfolio, the prepays are coming in at $450 million to $475 million a quarter.

We expect that it remains relatively constant here over the third and fourth quarter.

And yes, we have been replacing yields in the 2.20s with the securities in the 2.40s.

We had an acquisition last week, which I referenced in the new level of 2.50.

So obviously, as long as that continues and we continue to purchase at 2.40 or north thereof, clearly, it's accretive to what's being paid down.

And, Brett, on the competitive landscape and pricing, we operate in some very attractive markets and some very attractive business lines.

And so as you would expect, competition is always pretty strong and we just have chosen to stick to our discipline, which is really focused on long-term relationships where we can get appropriate returns in the business lines and markets that we like and really no change in strategy there.

Your next question comes from the line of Brian Klock with Keefe, Bruyette, & Woods.

So I have kind of a follow-up question for Curt on the auto Dealer Floor Plan business.

And I know the guidance you guys gave was for the typical sort of seasonal sell down that happens and as we go through the summer and fall months.

I guess considering, like you said, the cars are staying on the lots longer, should we expect the sell-down in the third quarter to be lower than what you've seen historically in the third quarter?

It's hard to anticipate.

Normally, the third quarter starts out pretty strong.

You start to see the slowdown sort of in the second half of the third quarter and then leading into the fall and then you would normally start seeing a little bit of build as we get into the latter half of fourth quarter.

So we're still anticipating that trend, and it's just too early to say if we would see a change there.

Okay.

And I guess, Pete, on the SNC portfolio, can you update us again on, I guess, the relative size of that quarter-over-quarter?

And, obviously, the asset quality trends are strong, trends you have would've reflected the SNC exam from the spring, correct?

Yes.

So about 20%, a little less than 20% of our portfolio are Shared National Credits, that would include deals that we agent, about 1/5 of those would be deals that we agent.

We very much use Shared National Credits as a way of not -- we don't use it as a way to grow the portfolio, we use it as a way to diversify the portfolio, particularly in businesses like energy, where we don't want a large deal use our balance sheet and have a large exposure yet, still play in that market where we like to be, which is the upper Middle Market.

So in our view, it's a way of getting the diversity that we want without taking the risk to the balance sheet.

And so that's really our focus on Shared National Credits.

As far as credit quality goes, it's very strong ex Energy.

Remember that most of our energy credits are Shared National Credits, so if you just pull those out, the rest of the SNC portfolio is in terrific shape.

You might mention as well, Pete, that those are underwritten just like you would underwrite any other credit.

And as we focus on it, we also look to build a relationship, even if we are not the agent with those customers.

That's right, that's right.

We have a time frame internally that if we don't have a full relationship with the borrower, then we're typically looking to exit.

And we do, as Ralph said, we underwrite those credits just like we would any single bank deal.

Great.

And, you're right, on Slide 9, the ex Energy the charge off ratio is still pretty low at 13 basis points, so that's pretty solid performance in that portfolio.

Yes.

We said all along that the charge-offs would be very manageable and so far, they have been and we expect them to continue to be.

Okay.

And my last question just -- I know that you've answered the question earlier, Ralph, on the deposits and it does seem like the drawdown in the commercial money market deposits in that segment are starting to get pulled through on the loan side.

The end-of-period loan growth was stronger than the average, and I know you don't do the segment loan disclosures and deposit disclosures on an end-of-period basis.

But it would seem that there could be that pull forward into the third quarter on the stronger loan growth.

I guess what I was wondering though is, we usually get the deposits to snap back after the seasonal soft second quarter, so would you expect there to be that sort of a headwind to deposit growth, which -- in the third to fourth quarter because of that activity coming into being drawn into a strong loan growth?

That's part of the total equation, but also we've got the caution that's still out there, too and seeing what's going on in Washington and in the economy.

So it's hard to really predict at this point.

Curt, do you want to add anything to that?

Yes, I would -- exactly what Ralph said.

It is hard to predict because we feel like we're seeing a drawdown in deposits on the commercial side, which is part of this whole equation of leading to some growth in our loan portfolio as clients are starting to deploy those.

But you're right, normally and if you look at last year, in the second half of the year, we would see these deposits starting to build some.

And so it's hard to know what that mix might be yet, we're still too early into the third quarter.

But we'll be watching there.

And it's likely to be some mix of both.

I will say that when you look outside of the commercial book, the business bank deposits, we did see growth in sort of core retail and Wealth Management.

And so those business lines have continued to grow for us.

And the last thing I'd say is that while we talk about deposit betas, we just would remind you that the majority, about 55% of our portfolio, is noninterest-bearing.

So really not very rate-sensitive overall.

Right.

And you guys have a pretty low deposit -- loan-to-deposit ratio still so based off the ability to fund.

Your next question comes from the line of Scott Siefers with Sandler O'Neill.

My first question is I'm just trying to sort of square up the credit cost guidance.

So all the numbers are all really good, the energy portfolios in pretty good shape, and I think you referred a couple of times to potential upgrades on the SNC portfolio.

So I'm just trying to square what would cause such pressure on that provision in the second half of the year?

If I'm reading the guidance correctly, I think that provision would basically have to double or more in the second half of the year relative to the first.

So just trying to get your sense for the thinking behind that?

Pete?

That's a full year guidance.

So what we put in there was the assumption that there would be a reserve release and that charge-offs would continue to be fairly benign, but in the lower end of what we would consider to be normal.

And so assuming there is no reserve release and charge-offs remain at that level, I think that's really where we'd come out for the year.

Okay, all right.

And then if I can...

Just bear in mind, we did have a fairly large reserve release in the first quarter.

And that made the first half provision quite low.

Yes, that's a fair point.

Okay.

If I can switch gears a little back to the costs, and I don't want to make you repeat yourself or anything, but I'm just trying to get a sense for the any underlying pressures on the expense side.

So if I look at the guidance by the fourth quarter this year, I think the quarterly expense run rate will be about where it was prior to when you started the GEAR Up initiative despite achieving quite a bit of cost savings.

So I know a good chunk of the expense ramp seems to be related to revenues, related to GEAR Up.

But just trying to get a better sense for sort of the any underlying pressures you're seeing that might be more than you thought or so what's going on there?

I wouldn't refer to it as underlying pressure.

When we came into the year, we knew that we would have a higher level of expense in the back half.

That was planned.

And that was all within that overall expense reduction range of 1% to 2% that we are now saying will be closer to 1%.

A big part of that back half -- well, first of all, you've got 3 additional days.

But we did plan, and we are continuing to plan for a step-up in technology spend.

We have projects that will drive customer enhanced interaction with the bank, and we are spot on to make sure those projects come to life.

That's what's going to drive a big piece of second half.

As you mentioned earlier too Dave, the volumes are increasing.

So on the revenue side are additional revenue with the expenses like in card and other things because of that.

And that's what caused that drifting of 1% to 2% to be closer to 1%.

Right.

Your next question comes from the line of Erika Najarian with Bank of America.

So with an 11.5% CET 1 ratio, you have a lot of capital for your risk profile, even if we don't get reg reform.

And I'm wondering, Ralph, as you think about continuing to improve your ROE, we absolutely understand the clear planning on the numerator side.

But I'm wondering over the next few years, especially if CCAR becomes less stressful, pardon the pun, how we should think about payout ranges over the next 2 years?

And also potential other uses of capital other than dividends and buybacks?

We have always, through history, I would say, have been very active with returning capital that we don't have an immediate use for.

And that would be one of the things that would be top of mind as things begin to change so that we could actually give more back, whether it be dividends or buyback from that standpoint.

And we always look for other opportunities.

Growth would be the best to use that capital.

And I would say we usually get the question as well on acquisitions, but that's something that has to be very focused for us and fit very well.

I think we've done 2 acquisitions over the last 20 years from that standpoint.

But we certainly view, with the management of capital, as one of our top priorities.

Dave, do you want to add anything to that?

No.

Completely agree with those comments, Ralph.

I mean, obviously, with the regulatory environment, we'll have to monitor that very closely.

Hopefully, we'll see a continued improvement in the tone relative to the whole CCAR process.

And a follow-up question on that.

The treasury proposal indicates that they'd like to lift the LCR restrictions on banks your size.

And as we think about longer-term rates sensitivity of your balance sheet, how much liquidity could be released if you don't longer have to be compliant with LCR?

Dave?

It's an interesting question.

Quite frankly, I look forward to the opportunity to prosecute that.

Off the top of my head, I would suggest to you that, that is a multibillion dollar number.

Got it.

And just one last one.

Ralph, your chairmanship, according to your proxy, ends in 2018.

What is your message for your long-term shareholders in terms of succession planning from here?

We continually look at succession planning and discuss that at the board level.

And when decisions are made, we make the appropriate announcements.

Your next question comes from the line of Geoffrey Elliott with Autonomous Research.

You've had close to 40 basis points of NIM expansion over the last couple of quarters.

At what point do you start to think about paring back the asset sensitivity of the balance sheet and locking in some of the benefits from higher rates?

Dave?

That's one we discuss a lot.

Geoffrey, we talk about that at least once a week.

And it's something that we monitor on a regular basis.

It is a constant discussion on asset liability committee meetings.

We have watched it very closely.

Quite frankly, one of the things we look at is what the opportunity would be on a 4-year slot.

Because that is what we would look to do when we start to do some synthetic hedging of the asset sensitivity.

That rate today just simply is not all that attractive.

A 4-year slot, we could pick up about 50 basis points.

And while the direction of the Fed fund rate maybe in question here at the moment in terms of whether or not we'll see another increase in '18, when you look at that dot plot over the course of a 4-year period, it certainly moves much more than 50 basis points.

So while there continues to be some downside risk relative to what rates could do if they were to move down, we don't see that today as really a high probability.

So as a result, we continue to monitor.

And when we think that it's appropriate, we will begin a hedging strategy.

And then just one quick follow-up.

The lease residual adjustment, can you give any more color on those leases, what sort of lease was driving that?

Yes.

We still have -- and we exited in terms of new transactions years ago, we exited this business.

But years ago, we did have some transactions where we used leveraged leases.

So at fairly large asset, single assets, fairly large, we have 2 of those remaining.

And those assets have, I believe, 6 years and 8 years yet to run.

We annually challenge the expected residual value.

We did that this quarter, and we made an adjustment on those 2 respective assets given the expected market condition.

Your next question comes from the line of Scott Valentin with Compass Point.

Just with regard to the TLS business, potential changes in healthcare.

Are there any concerns?

Or are you guys monitoring the portfolio for any potential pressure?

We've seen some banks report, I think, some hospital issues but just wondering if there's any exposures on the TLS portfolio?

Pete?

We have not seen any migration with regard to the life science portion of our technology and life science book so far.

The -- most of the businesses that are in Technology and Life Science that are connected with healthcare are relatively unaffected by changes in the healthcare law.

And so we're cautious about it and careful about that, but it doesn't really come into play in a big way in that business.

Okay.

And then just going back to the kind of the provision and reserving.

It sounds like provision expense -- I mean, I guess with the guidance you've given, overall reserve level should remain about where they are of the portfolio, I'm just wondering you guys have a pretty healthy reserve level compared to the peers, if there's room for that to come down over time or that's just where you guys feel comfortable operating given the historical performance of the portfolio?

Pete?

Yes, we look at it quarter-to-quarter and sometimes, it's lower than it is today and there's been times that it's actually been higher.

And so we'll look at it again at the end of this quarter.

Obviously, Energy is a driver, but there are other factors that we have to look at as well.

Your next question comes from the line of Peter Winter with Wedbush Securities.

My question is on commercial real estate.

If I look at end-of-period loans, the Commercial Real Estate portfolio has been trending lower.

And then secondly, criticized loans in Commercial Real Estate have increased the last 2 quarters.

I'm just wondering if you could talk about both those?

Yes.

Pete?

Well, as far as the credit quality in Commercial Real Estate, it's been pristine.

And so we have one relatively large credit that we did downgrade in this past quarter.

We have absolutely no concerns about the ability to repay, but there are certain things that have happened on it that required us to downgrade it, but we feel very good about the asset, we feel very good about the sponsorship and we do not feel there is any risk of loss there.

And as far as the strength of our Commercial Real Estate portfolio, it's performing extremely well.

When you think about our Commercial Real Estate book, first of all, we're overweight with regard to owner-occupied real estate, which performs more like C&I.

And then we've got kind of underweight with regard to true Commercial Real Estate.

Most of that is in the line of business and most of our Commercial Real Estate risk in line of business is Class A multifamily construction.

And we really like Class A multifamily construction for a number of reasons, but one of which is how well it performs in downturns.

And Houston is a perfect example of that right now, where multifamily is outperforming office and retail down there.

And that's why we focus on it.

But we feel very good about the Commercial Real Estate portfolio and because of it's heavy -- we're heavy weighing towards owner-occupied and heavy weighing towards multifamily construction we think it's well positioned in the event of a downturn.

You might mention how the equity portions have gone up.

Yes.

Just -- this is pretty much true of most of the products in a lot of the business but in particular, multifamily.

Moving 35% to 45% equity in those deals and so you've got a lot of room for rents to move against you when you have that much equity in it -- in the project.

I might just add, Ralph, that...

Sure.

The production levels have remained pretty consistent in that business but most of it is moving to the permanent markets fill pretty quickly.

And so you'll see balances fluctuate a little bit.

I wouldn't read too much into that overall.

So we were down a little bit in the quarter, but a lot of that is less about production, more about just how quickly, given that we really do construction financing, how quickly it's moving to the permanent market.

Okay, great and just one quick follow-up.

Just going back to the deposit betas, with the impact to net interest income with the June rate hike.

If the deposit beta remains at 0, what would be the impact to net interest income?

Dave?

I think if you look at the range, which, obviously, move it to the higher end of the range which I think is about 55, 60 as you get to...

30 to 40 with...

30 to 40.

I'm sorry, yes, I'm thinking of the March rate rise, I apologize.

That's okay.

Okay, so the 25% deposit beta is really the $30 million impact, but 0 would bring it to $40 million?

That's directionally correct.

Your next question comes from the line of Ken Zerbe with Morgan Stanley.

Just on GEAR Up, is there any way for us on the outside of the bank to know that you've actually achieved like $180 million of GEAR Up pretax this year?

Because I'm trying to -- I'm having a hard time separating out sort of the GEAR Up versus the impact on earnings from higher rates and from loan growth.

Like how do we know or how we do we see that ourselves?

Dave?

Well, if you focus on expenses, you can easily back out the effect of the rate rises from -- in terms of if you just go in and use last year's NIM versus this year's, then look at the difference in terms of pretax earnings, there is a dramatic reduction in expense.

Albeit a relatively modest increase in revenue, GEAR Up is much more focused on expense reduction than it is revenues.

And remember this year we said $150 million in expense reduction, $30 million in revenue, focused on the expenses.

We're focused on both.

But if you're trying to get the math to line up to support the statement, focus on expenses.

Look at that efficiency ratio and compute that efficiency ratio even without the rate rises, it's down.

And that's the best way I think I can articulate that we are achieving what we expected to achieve with GEAR Up.

And it's tracked.

And internally, we track it in extreme detail.

Got it.

Okay, that helps out a lot.

And then last question I had, when you do ultimately see customer demand for exception pricing, how willing are you guys going to be to accept that, like, versus just saying no and letting the customer walk away, if that's what they choose?

We have a lot of numerous, numerous, numerous outstanding customers that have been with us a long time.

We are very focused on taking care of our customers.

Yet, quite frankly, when they approach us about the potential for an adjustment, we look at it, and sometimes, we'll have discussions in terms of a little bit of give and take, but we're here to serve our customers.

Got you.

Okay, the reason I asked is because some other banks talk about having a lot of excess deposits and that's one of the reasons why deposit betas may remain low is because they're willing to let those customers kind of walk away.

But if I understood you right, it sounds like you're in the opposite end, that if they ask you, they will get it.

We are focused on relationships in the total, and that's very important for the long-term benefit, of not only the customer, but of us.

Your next question comes from the line of Dave Rochester with Deutsche Bank.

Sorry if I missed this earlier, but how do you guys think about changing the earnings credit rate?

Have seen any competitors do it?

And when do you think -- if you haven't done that, we might start seeing you adjust those in terms of additional rate hikes coming up?

How many more do you think that you need to see before you start doing that?

Yes, well, again, it's very similar to deposit pricing.

We have seen very few requests, and I do mean very few requests on ECA.

Because quite frankly, until the credit has been fully utilized, it doesn't really matter.

And our utilization, while it's moved up, it's not 100%.

But again, we'll watch that, we'll be competitive.

I think if we do continue to see rates rise, we'll likely, just as we would expect to see continued expectation on deposit betas, you can expect some relative adjustment on ECA.

We just have not seen it today.

Okay.

And then I guess, how do you think about the cash balance going forward that declined in helping them out a little bit?

I was just wondering how much more do you think, just with LCR in the background there, you think you can actually invest to loan growth going forward if the deposit growth doesn't necessarily materialize?

We continue to have an excess level of cash.

It's well in excess of what would be required even to maintain LCR with an appropriate cushion.

So we're well positioned today.

Your next question comes from the line of Terry McEvoy with Stephens.

Just one question.

Earlier on the call you mentioned shorter dwell times in mortgage warehouse.

I'm wondering if you could just shed some light on this year, what you've seen maybe versus last year.

And then your updated outlook for '17 loan growth, does that assume shorter dwell times within that business?

Curt?

Yes, Terry, on the dwell times, I would say it's down a few days year-over-year.

So if you look at sort of first half of '16 versus where we are year-to-date in '17.

So it is having an impact on the outstandings in the portfolio overall.

That coupled with slowdown in the refi business.

Positively for us, we weigh more towards the purchase side, and that has remained relatively strong and we're in the season right now of heavy purchase activity and NDA forecast while refi down, NDA is still forecasting for purchase volume to be up for the full year.

And then secondly, I think, helping us there to sort of offset that decline in refi and the dwell time is the fact that we continue to be in a net acquiring in our position in terms of new customer relationships.

In fact, we brought in 2 very nice relationships in the second quarter.

And so we are forecasting down year-over-year for the full year for mortgage banker finance.

But those 2 items, I think, are working in our favor to help us offset some of that year-over-year decline.

I'll now turn the conference back over to Ralph Babb, Chairman and Chief Executive Officer, for any further remarks.

I just want to thank everybody for staying with us on the call today and your interest and support of Comerica, and I hope you all have a great day.

Ladies and gentlemen, this concludes today's conference.

Thank you all for joining.

You may now disconnect.